Just Passin' Through

When a subcontractor is not paid, the first questions asked are, “Who is a friend? Who is an enemy?” Do you sue everyone, or do you join forces? The subcontractor’s decision can have long-range consequences. For the purposes of this article, the payment issue involves unresolved changes, extras and other claims, and it does not involve the collection of undisputed contract earnings.

The problem of suing the owner

There is an ancient concept in the law known as “privity.” Even the word is archaic. There is horizontal privity, privity of blood, privity of estate and vertiale privity. Then, there is privity of contract.

Privity of contract means there is an agreement connecting two people or companies. The project owner signs an agreement with the general contractor, and by doing so, there is a privity of contract created between those two entities. Similarly, the subcontractor is in privity with the general but not with the owner.

Maintaining this old concept in a modern world has proven difficult for the courts. There was a time when you could not sue someone for purely financial losses unless there was privity with the party who harmed you. Personal injury and property damage claims were treated separately as torts.

Major changes have eroded this concept. But generally, a subcontractor on a construction project cannot sue the owner directly for unpaid costs. Strictly speaking, even mechanic’s liens are not claims against the owner, they are against the property. This rule applies even where the owner ordered a change or caused a job disruption and knew the financial impact it would have on the subcontractor.

The avenue of relief is for the subcontractor to sue the general, and then the general brings in the owner. This procedure is clumsy and may cause the general to raise its own defenses to your claims. After all, the general does not want to be liable for owner-caused problems.

The pass-through claim

The general contractor may be willing to help the subcontractor pass its claims through to the owner in the general’s name. The claim then becomes the general contractor’s, and the privity problem is solved. However, there is a long line of authority that the general cannot pursue the subcontractor’s claims unless and until the general acknowledges liability for them.

A number of techniques have been used to get around this dilemma. The idea is to make the general contractor liable to the subcontractor and yet not liable at the same time. One of the early concoctions was the “Mary Carter” agreement, named after the Mary Carter paint company (Booth v. Mary Carter Paint Co., Fla. App. 1967). There are variations, but the common theme is to have the general contractor pay a part of the subcontractor’s claim, and then pursue the owner for the full value.

The first amount recovered would be kept by the general contractor to reimburse it for the “advance” and, beyond that, recovery would be shared on some percentage basis. This formula has particular value where the general contractor has its own claims against the owner and does not want the sub claiming it was the general’s fault. The general contractor would rather present a united front against the owner.

Mary Carter agreements are not acceptable in all jurisdictions, according to John E. Benedict’s “It’s A Mistake to Tolerate the Mary Carter Agreement,” 87 Columbia L. Rev. 368 (1987).

The Severin Doctrine

Named after the case Severin v. United States, 99 Ct. Cl. 435 (1943), this “doctrine” is applied fairly regularly in federal government contracts. The Severin Doctrine is actually a limitation on pass-through claims: the general may only “sponsor” the sub’s claims if the general itself is not the culpable party. In broader terms, the government will not be liable on the sub’s pass-through claims if the general would have defense to the claims.

This limitation was recently applied to defeat a sub’s delay claim, as the government showed the general contractor had a “no damages for delay” clause in its agreement with the subcontractor. The general could not be liable for the costs of delay to the sub and, therefore, could not act as a sponsor of those barred claims to the government.

In like manner, the general cannot sponsor a subcontractor’s claim for breach of contract by the general. To use Severin, the claim must be couched as one for an “equitable adjustment,” a term of art in government contract law.

The liquidating agreement

Whether called a liquidating, liquidation or consolidation agreement, the concept is the sub releases the general from liability, and in exchange, the general agrees to pursue the claims on the sub’s behalf. The terms of such an agreement must be carefully drafted.

It is not uncommon to have a liquidating agreement built into the terms of the subcontract. For example, there are clauses that provide that any claims arising from owner fault may be pursued only through the general contractor, and recovery is limited to whatever the general obtains. Where this type of clause appears, there often is a second part stating that claims against the general not caused by the owner will go to court or arbitration.

The concept of a split disputes clause was discussed here some years ago (ELECTRICAL- CONTRACTOR, December 2002). Suffice it to say that the subcontractor is faced with a choice and a dilemma: it must decide early in the disputes process whether it wants to go after the general, join with it against the owner, or do both.

A note of caution with liquidating agreements: The subcontractor should make certain that it has some authority or influence over the owner/general’s settlement of claims. Without this authority, the general is relatively free in entering into a settlement that might disappoint the sub.

A second note of caution is to make certain that the agreement addresses the potential for back charges and counterclaims by the owner.

Subcontractor claims against a state

There is no general rule. State governments will raise the defense of sovereign immunity for claims by any party not in privity with it. Each state’s law must be consulted to determine the viability of sponsored or pass-through claims.

Conclusion

The idea of a passing through claims can be very attractive. There is the benefit of joining forces and, by doing so, resolving potential cross claims among some of the parties. There also can be a reduction of costs by avoiding duplication of efforts.

The subcontractor will need to know all of the pertinent terms of the owner/general contractor agreement that could limit or eliminate certain claims. Legal advice should be sought before you bind yourself to Severin.